Post-Establishment Phase: FDI Screening Decisions and the Treatment of Retroactive Measures in Investment Arbitration
Authors: Bart Wasiak (Arnold & Porter Kaye Scholer (UK) LLP) and Naina Gupta (Arnold & Porter Kaye Scholer (UK) LLP)
Introduction
Decisions concerning the screening of foreign direct investments (“FDI”) are often taken at the post-establishment phase—after the foreign investor already has made an investment in the host State—but may have an effect on the validity of the investor’s earlier acquisition or otherwise adversely impact its existing investment. For example, a State may decide that the investor’s purchase of a local company must be unwound or that its proposed disposal of assets to another foreign entity must be blocked. The affected investor may challenge the decision in investor-State dispute settlement (“ISDS”) proceedings and argue that the State has breached its obligations under an applicable investment treaty due to the ‘retroactive’ effect of the FDI screening decision. This blog post discusses three potential scenarios and how they may be addressed by ISDS tribunals.
I. The Exercise of ‘Call-in Powers’: A Retroactive Measure?
FDI screening regimes in many countries grant the government a ‘call-in power’: the power to review certain specified types of foreign investments, and then potentially to condition or unwind such investments on national security grounds. For example, the United Kingdom’s National Security and Investment Act 2021 (“NSIA”) allows the Secretary of State to conduct a national security assessment in respect of certain types of transactions completed in the preceding five years and to issue a ‘final order’ that may require the transaction to be unwound.
The UK government issued its first-ever NSIA divestment order in respect of a January 2021 acquisition by LetterOne, a Luxembourgish company, of Upp, a UK fibre broadband provider. In December 2022, the Secretary of State ordered LetterOne to divest of its shares in Upp, on the ground that Letter’s ultimate ownership by sanctioned Russian individuals posed a risk to the UK’s national security. The English High Court subsequently rejected LetterOne’s challenge to the order, and the Court of Appeal upheld the judgment. A further appeal to the Supreme Court is pending.
The LetterOne decision has not led to any publicly known ISDS proceedings. Indeed, no ISDS tribunal has yet considered whether an investment screening decision requiring the investor to divest of an existing investment could breach the host State’s investment treaty obligations. But what insights can be gained from ISDS cases concerning allegedly ‘retroactive’ measures?
In Cairn Energy v. India (Final Award, 21 December 2020), the claimants challenged India’s imposition of a tax on an already-completed transaction. India had introduced the relevant tax through a 2012 legislative amendment, with retroactive effect from 1962. The claimants argued that, by applying the newly introduced tax to the claimants’ 2006 restructuring transactions, India breached its investment treaty obligation to provide fair and equitable treatment (“FET”). The tribunal agreed. It held that by retroactively applying, without a specific justification a new tax burden on transactions that were not taxable at the time they were carried out, India ‘deprived the Claimants of their ability to plan their activities in consideration of the legal consequences of their conduct, in violation of the principle of legal certainty,’ which the tribunal considered to be a core element of the FET standard (para. 1816).
An investor adversely affected by an order to divest of an already-acquired investment may rely on Cairn to argue that the order is inconsistent with the principle of legal stability and deprives the investor of the ability to predict the legal consequences of its conduct: while the investor acquired its investment lawfully, in accordance with the domestic law, the government’s subsequent decision invalidated or unwound the acquisition. However, the host State may counter-argue that the national security concerns underlying the divestment order constitute a ‘specific justification,’ which the Cairn tribunal held can excuse a retroactive measure (paras. 1784, 1816).
The decision in RREEF Infrastructure v. Spain (Decision on Responsibility and on the Principles of Quantum, 30 November 2018) is similarly illustrative. The arbitration was one of multiple ISDS cases concerning changes to the Spanish support system for renewable energy sources (“RES”). The claimants argued, among other things, that the changes were retroactive because they included a ‘claw-back’ on past remuneration: the investor’s past earnings were taken into account to calculate its future remuneration (para. 292). Spain countered that the amended RES-support system was not retroactive because it did not affect ‘acquired rights’ and only ‘ha[d] effects towards the future’ (para. 299). But the RREFF tribunal sided with the claimants. It acknowledged that a State’s obligation to create a stable environment for foreign investments ‘does not mean that regulatory regimes cannot evolve’ (para. 316). Nevertheless, it found that Spain had acted in breach of its obligation ‘to respect the principle of stability’ because the claw-back mechanism involved reducing the investor’s past remuneration that constituted an ‘acquired right[]’ of the investors (paras. 325, 328).
The Cairn and RREEF tribunals both found that the disputed measures were ‘retroactive’ and amounted to treaty violations. Their decisions suggest that ISDS tribunals are likely to scrutinize closely investment screening decisions that retroactively affect the validity of an already-completed transaction or the investor’s ‘acquired rights’ more broadly. Nevertheless, neither case is directly analogous to the LetterOne scenario, and both tribunals emphasized that States may validly implement retroactive measures in certain circumstances. Moreover, as discussed immediately below, other tribunals have distinguished between ‘true’ retroactivity and measures that merely amend, on a going-forward basis, the regulatory environment in which the investor had invested.
II. Restriction on the Disposal of Assets: An Application of Measures to ‘Situations in Progress’?
A small but growing number of investment-screening cases have involved a prohibition on national security grounds on the disposal of assets to a foreign buyer (an ‘outward’ prohibition). While such cases have typically concerned the proposed disposal of assets held by a domestic company, outward prohibitions have also been issued in respect of the disposal of assets held by an existing foreign investor to another foreign entity.
In 2023, the French Ministry of Economy issued an FDI screening decision blocking a proposed takeover by Flowserve Corporation (a US company) of Velan Inc. (a Canadian company), whose French subsidiaries manufacture valves used in nuclear reactors. The Ministry’s decision reportedly followed its determination that commitments made to mitigate national security risks associated with the transaction were insufficient.
The Velan decision did not affect the validity of a previously concluded transaction. However, its effect was to prohibit an existing foreign investor (Velan) from disposing of its French assets to a specific foreign entity (or, more specifically, from being taken over, along with its French assets, by such foreign entity)—an outcome that arguably adversely impacted the foreign investor’s existing rights and the legal framework in which it had invested. How might ISDS tribunals assess such a measure?
The award in Parkerings v. Lithuania (Award, 11 September 2007) offers a useful insight. The claimant’s investment involved a contract with the municipality of Vilnius to provide a car parking system. The claimant alleged that a series of legislative amendments had invalidated several provisions of the contract, significantly reducing the profitability of the investment. It argued that the amendments had frustrated its ‘legitimate expectation’ that Lithuania would ‘maintain a stable and predictable legal and business framework’ (para. 322). But the tribunal rejected this argument. It held that, while an investor in principle ‘has a right to a certain stability and predictability of the legal environment of the investment,’ unless the investor has secured from the government a so-called ‘stabilisation clause,’ ‘there is nothing objectionable about the amendment brought to the regulatory framework existing at the time an investor made its investment’ (paras. 332-333). The tribunal rejected the claimant’s claim, including in light of the absence of a stabilisation clause in the contract.
The Parkerings decision illustrates that, absent a specific promise of stability, States are generally free to amend their legislative and regulatory framework with prospective effect, even if such changes affect the investor’s existing investment-related rights. Applied to the Velan scenario, the Parkerings tribunal’s holding suggests that, unless the foreign investor could demonstrate that the State had provided it with a specific promise of stability in respect of the investor’s ongoing ability to dispose of its investment, the tribunal would be unlikely to find that a prohibition on divestment of assets to a foreign entity amounted to a breach of the State’s promise to provide a stable legal framework.
A similar principle emerges from Charanne v. Spain (Final Award, 21 January 2016), where—like in RREEF—the tribunal assessed whether certain changes to the Spanish RES-support system were compatible with Spain’s investment treaty obligations. The claimants argued that the changes, which involved lowering the tariffs payable to RES producers, breached their legitimate expectations because they ‘ha[d] retroactively affected the legal and economic regimes established by previous regulations on which the Claimants relied upon’ (para. 268). The tribunal disagreed that the changes were retroactive, noting that the changes applied only prospectively, to existing RES plants. It held that, ‘there is no principle of international law prohibiting a State to take regulatory measures with immediate effect in situations in progress except when there are specific commitments [such] as those resulting from a contract’ (para. 548).
The Charanne award demonstrates that ISDS tribunals are unlikely to consider as ‘retroactive’ measures that apply only prospectively, even if they adversely affect the legal regime in which the investor had invested. A foreign investor therefore likely would encounter some hurdles in seeking to establish that an ‘outward’ prohibition on the disposal of assets to a foreign entity amounted to a ‘retroactive’ measure, in breach of the investor’s legitimate expectations.
III. Domestic Procedural Safeguards: A Viable Defence?
Domestic FDI screening regimes typically provide for certain procedural safeguards—such as defined review timelines, notice to affected parties, and the right to be heard—including to avoid the potential unfairness of retroactive decisions. While national courts are likely to accord significant deference to the government on the substance of its national security-driven investment screening decisions, they are more likely to censure decisions that fall foul of the applicable procedural rules.
The 15 November 2023 judgment of the Administrative Court of Berlin in the Heyer Medical case demonstrates that domestic-law procedural safeguards can provide affected investors with a meaningful remedy. In July 2019, Heyer Medical—a German manufacturer of medical ventilators—was sold to a Chinese company, Aeonmed. In April 2020, during the COVID-19 pandemic, the German Ministry of Economic Affairs and Climate Action (“BMWE”) became aware of the sale. In April 2020, the BMWE initiated an official review of the acquisition and, more than two years later, in August 2022, it retroactively prohibited the transaction. Following a legal challenge by Aeonmed, the Administrative Court struck down the BMWE’s decision on procedural grounds. The Court found, among other things, that the BMWE had not complied with a requirement under the Foreign Trade and Payments Ordinance that the official review be initiated within three months of the BMWE becoming aware of the acquisition.
In the Heyer Medical case, the foreign investor was able to obtain a remedy through the domestic courts. But how would the same scenario likely play out in front of an ISDS tribunal?
The award in Thunderbird v. Mexico (Award, 26 January 2006) is instructive in this respect. The claimant had invested in several Mexican gambling facilities, after having consulted a government agency about the domestic gambling regulations. It alleged that the government’s subsequent decision to close the gambling facilities amounted to a breach of the ‘minimum standard of treatment’ (para. 185). In dismissing this claim, the tribunal observed, among other things, that the claimant had been given a full opportunity to be heard and the authorities proceeded in a generally procedural proper manner. The tribunal concluded that it could not ‘find on the record any administrative irregularities that were grave enough to shock a sense of judicial propriety and thus give rise to a breach of the minimum standard of treatment’ (para. 200).
The Thunderbird decision suggests that the availability of domestic-law procedural remedies may be relevant to an investment tribunal’s assessment. While an ISDS tribunal is unlikely to dismiss an investment treaty claim on the sole basis that the State authorities had complied with applicable procedural requirements or that the investor had had access to remedies, those considerations may play an important role in the tribunal’s assessment of the State’s conduct. Procedural safeguards thus play an important role in FDI screening regimes.
Conclusion
Several aspects of investment screening mechanisms create a risk that a dissatisfied investor may consider a screening decision ‘retroactive’ and in breach of the State’s investment treaty obligations. These include: the fact that the State authorities may not become aware of the transaction until sometime after it completed, and may block such transaction with retroactive effect; the possibility that the State’s national security assessment may change over time; and the risk that a foreign investor may unexpectedly find itself unable to dispose of its investment through a sale to a specific buyer.
A review of selected ISDS jurisprudence suggests that FDI screening decisions that retroactively affect the investor’s acquisition of its investment are likely to face close scrutiny, though tribunals have recognised States’ general power to evolve their regulatory regimes and the fact that a State may have a valid ‘specific justification’ for a retroactive measure.
Where an investment screening applies only prospectively—such as where the authorities block a proposed sale of the local company—the investor may be less able to demonstrate a breach of the investor’s legitimate expectations, barring specific commitments made by the State to the investor.
Finally, in defending ISDS claims, States may find it useful to draw tribunals’ attention to domestic-law procedural safeguards and remedies available to the investor. Conversely, where the State authority responsible for investment screening decisions has failed to accord sufficient due process to the affected investor, the State may be more exposed to findings of breach under its investment treaty obligations.
